public disclosure authorized - world bank€¦ · this report is part of a wider study supported by...

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© INTERNATIONAL FINANCE CORPORATION & MicroSave | www.ifc.org | www.MicroSave.org | [email protected]

DEPOSIT ASSESSMENT IN NEPAL

© 2011 INTERNATIONAL FINANCE CORPORATION

All rights reserved. May not be reproduced in whole or in part by any means without the written consent of the International Finance Corporation (IFC). This information, while based on sources that IFC considers to be reliable, is not guaranteed to be accurate and does not purport to be com-plete.

This information shall not be construed, implicitly or explicitly, as containing any investment rec-ommendations, and, accordingly, IFC is not registered under the U.S. Investment Advisers Act of 1940. This information does not constitute an offer of or on behalf of IFC to purchase or sell any of the enterprises mentioned, nor should it be considered as investment advice.

The denominations and geographical names in this publication are used solely for the conve-nience of the reader and do not imply the expression of any opinion whatsoever on the part of IFC, the World Bank, or other affi liates concerning the legal status of any country, territory, city, area, or its authorities, or concerning the delimitation of its boundaries or national affi liation.

Any views expressed herein are those of the authors and do not necessarily represent the views of the World Bank or International Finance Corporation.

Commissioned by IFCs Access to Finance Advisory Department

Published in the United States of America, May 2011

© MicroSave

MicroSave has over a decade of experience in providing practical, client-responsive, market-led solutions to assist fi nancial service providers and institutions working with low-income clients succeed and achieve their mission and business objectives. It has a history of working alongside fi nancial institutions, telecom operators and FMCG companies, livelihood institutions and devel-opment agencies of varied institutional forms and sizes throughout Africa and Asia. It has under-taken assignments in Afghanistan, Bangladesh, Cambodia, Cameroon, China, Colombia, Egypt, Ethiopia, Ghana, India, Indonesia, Kenya, Malawi, Nepal, Nigeria, the Philippines, Sierra Leone, South Africa, Sri Lanka, Sudan, Tanzania, Uganda and Vietnam.



i

Table of ContentsList of Tables iList of Figures iiList of Case Studies iiAcknowledgments iii List of Abbreviations iv1. Background of the Study 12. Macroeconomic Environment 1 2.1 Demographics, Regional Differences and Migration Patterns 1 2.2 Poverty 4 2.3 Human Development 6 2.4 Macroeconomic Trends 6 2.5 Doing Business in Nepal 103. Legal and Regulatory Framework and Financial Infrastructure 10 3.1 Formal Institutions for Deposit Mobilisation in Nepal 11 3.2 Semi-Formal Institutions for Deposit Mobilisation in Nepal 20 3.3 Informal Institutions for Deposit Mobilisation in Nepal 21 3.4 Insurance Sector 21 3.5 Quality of Supervision 23 3.6 Government Development Initiatives in Microfi nance 23 3.7 Depositor Protection/Deposit Insurance 26 3.8 Liquidity Management 27 3.9 Financial Literacy 27 3.10 Capacity Building Resources and Network Institutions 284. Microdeposit Service Providers: Outreach, Methodologies and Products 29 4.1 Commercial Banks, Development Banks and Finance Companies 30 4.2 Microcredit Development Banks and FINGOs 36 4.3 Savings and Credit Co-operatives in Nepal 38 4.4 Insurance 395. Client's Needs and Preferences 40 5.1 Purposes of Savings 41 5.2 Life Cycle Events That Create Financial Pressure 42 5.3 Institutions Being Used and Existing Savings Products 43 5.4 Preferences with Regards to Product Attributes and Institutions 45 6. Summary and Recommendations 49 6.1 The Way Ahead 50

LIST OF TABLESTable 1: Macroeconomic Indicators 6 Table 2: Summary of Regulators and Applicable Acts in the Formal Financial System in Nepal 12Table 3: Minimum Paid-up Capital Requirement for Financial Institutions (in Millions) 13Table 4: Scope of Activities Allowed to Each Type of Formal Financial Institution 14Table 5: Share Capital Requirement for Licensed SACCOs 18Table 6: Number of Contributors to EPF 20Table 7: Number of Commercial Bank Branches by Ecological Region 30Table 8: Financial Expansion and Deepening Indicators – Commercial Banks 31Table 9: The Self-Discipline Member System of Chhimek Bikas Bank 37Table 10: Distribution of Households Reporting Usage of Cash by Area of Usage Across Domain 44


ii


LIST OF FIGURESFigure 1: Geographical and Administrative Divisions of Nepal 1Figure 2: Population Changes During the 90-Year Period, 1911-2001 1Figure 3: Population Pyramids, 1971 and 2001 2Figure 4: Population by Ecological Region 2Figure 5: Population by Development Region 3Figure 6: Urban and Rural Population 3Figure 7: Literacy Rates and Distribution of Male/Female Among the Literate Population 3Figure 8: Occupations and Segregation by Mountain, Hills and Terai 4Figure 9: Poverty Headcount Ratio by Development Region 5 Figure 10: Poverty Headcount Ratio by Rural/Urban 5Figure 11: Poverty Headcount Ratio by Ecological Region 5Figure 12: Real GDP and GDP Growth 7Figure 13: Structure of the Economy (% GDP) 7Figure 14: Remittance Income as a Percentage of GDP 8Figure 15: Growth in GDS as a Percentage of GDP 9Figure 16: Per Capita Income Against Per Capita GDS 9Figure 17: NRB Licensed Institutions 11Figure 18: Number of Co-operatives in Nepal by Category (April 2009) 21Figure 19: Types of Insurance in Nepal 22Figure 20: Institution-Wise Share in Aggregate Deposit 29Figure 21: Distribution of Deposits (2009) 29Figure 22: Distribution of Loans (2009) 29Figure 23: Region-Wise Distribution of Bank Branches (A, B and C) 30Figure 24: Deposit Composition of Commercial Banks 33Figure 25: Deposit Composition of Development Banks 33Figure 26: Deposit Composition of Finance Companies 33Figure 27: Purpose of Savings 41Figure 28: Life Cycle Analysis – Financial Pressure and Prominence 42Figure 29: Where People Save 43Figure 30: Products Currently Being Used 44Figure 31: Product Attribute Ranking 45Figure 32: Savings Management Cycle 48Figure 33: Relative Preference Ranking - Institutional Strengths and Product Attributes 49

LIST OF CASE STUDIESCase Study 1: Remittances in Nepal - Vishnu's Family in Hasposa VDC, Sunsari 8Case Study 2: Alternate Delivery Channels of Commercial Banks 32Case Study 3: M-Banking in Nepal - Scope and Challenges 34Case Study 4: Microinsurance Initiatives at Nirdhan Uthan Bank Ltd 40Case Study 5: Losing Money in Informal Groups 46Case Study 6: Convenience of Co-operatives Versus Trust of Banks 48


iii


ACKNOWLEDGMENTS

Deposit Assessment in Nepal was written by Diana Lewin, Anil Paul, Manoj K Sharma, and Graham A.N. Wright. This report is part of a wider study supported by the International Finance Corporation (IFC). The 'Industry Mapping of Small Balance Deposits in South Asia (India, Nepal, Sri Lanka and Bangladesh)' is a comprehensive market study that details the needs and preferences of micro-savings clients in South Asia and to support the development of client-responsive products and delivery processes. IFC conceptualised, guided, and supported this study and its wider dissemination. Provision of fi nancial services, especially savings and insurance, is at an inflexion point and all stakeholders are concerned about fi nancial exclusion of low-income populations. This study provides direction and enables fi nancial institutions to offer tailored products to low-income people. IFC and MicroSave would like to recognize, with deep appreciation, the fi nancial support from the Netherlands' Ministry of Foreign Affairs for this study. Grant support from the trust fund enabled this study that will benefi t vast numbers of fi nancially underserved people worldwide.

This report is the result of the ideas and hard work of many people at many organisations, especially the commercial banks, development banks, microfi nance development banks, credit cooperatives, fi nancial NGOs and insurance companies that were a part of this study. MicroSave is also grateful to the Centre for Microfi nance Nepal, specially Sushila Gautum and Tejhari Ghimire, Sabin Raj Shrestha, SASFP, World Bank and sector experts who gave their time and support to the study. We especially recognise Amit Kumar Garg and Nitin Garg for their support in institutional assessment and market research, which were an integral part of this study.

Above all, we thank the clients who patiently gave us their time during the extensive market research for the report. Their contributions regarding savings products and services, and the way in which they manage their fi nances without many options provided invaluable insight. We hope and believe that the future for fi nancial inclusion is bright, and that this report will play a role in informing the overall direction, products, and the delivery channels for broadening and deepening the outreach of formal fi nancial systems.

MicroSave Team



iv

LIST OF ABBREVIATIONSBAFIA Banking and Financial Institutions ActCB Commercial BankCBB Chimmek Bikas BankCD Credit-to-DepositCIT Citizen Investment TrustCMF Center for Microfi nanceDB Development BankDCGC Deposit Credit Guarantee Corporation EBL Everest Bank LimitedEPF Employees' Provident Fund FC Finance CompaniesFINGO Financial Intermediary NGOGDP Gross Domestic ProductGDS Gross Domestic SavingsIB Insurance BoardKSK Karmachari Sanchaya Kosh (Employees' Provident Fund)MBAN Microfi nance Bankers' Association of NepalMDB Microcredit Development BankMIFAN Microfi nance Association of NepalNBA Nepal Bankers' AssociationNEFSCUN Nepal Federation of Savings and Credit Co-operative UnionsNIBL Nepal Investment Bank Limited NLK Nagarik Lagani Kosh (Citizen Investment Trust)NPR Nepalese RupeeNRB Nepal Rastra BankNUBL Nirdhan Uthan Bank LimitedPOSB Post Offi ce Savings BankRMDC Rural Microfi nance Development CentreRRDB Regional Rural Development BankRSRF Rural Self Reliance FundSACCOs Savings and Credit Co-operativesUSD United States Dollar

Exchange Rate: 1 USD = 73.19 NPR


1


1. BACKGROUND OF THE STUDY

IFC's Access to Finance (A2F) department caters to both policy and project-related advisory work on fi nancial markets, fi nancial institutions and fi nancial infrastructure. Microfi nance is a core product of A2F and expanding small-scale deposits is a fl agship initiative. With numerous large, successful and internationally known institutions in Bangladesh, India, Nepal and Sri Lanka, microfi nance is well-established in South Asia. For a variety of reasons, however, most institutions focus on microcredit and the development of savings services has lagged seriously behind. This paper surveys the current supply and demand for microdeposit services in Nepal.

2. MACROECONOMIC ENVIRONMENT

2.1 DEMOGRAPHICS, REGIONAL DIFFERENCES AND MIGRATION PATTERNS1

• Ecologically, Nepal is divided into three areas: the Terai2, hills and mountains, and administratively into fi ve development regions: far-western, mid-western, western, central and eastern.

• The fi ve development regions are further divided into 14 zones, 75 districts and 3,915 village development committees (VDCs).

• The population of Nepal in 2001 was 23.15 million, with a population density of 157.3 persons per km2.

• Life expectancy at birth is 67 years.3

1 Unless otherwise stated, all population statistics are extracted from the Population Monograph of Nepal, Central Bureau of Statistics, Kathmandu, Nepal, 2003.

2 The word Terai is presumed to be derived from Persian, meaning “damp”. Various Hindi and Urdu dictionaries also defi ne it as land at the foothills of mountains, damp and swampy. Encyclopaedia Britannica implies the meaning of “Terai” as “moist land”.

3 World Bank Statistics.

3 Ecological Regions

5 Developent Regions

14 Zones

75 Districts

3,915 VDCs

-

50

100

150

200

-

5

10

15

20

25

1911 1920 1930 1941 1952 1961 1971 1981 1991 2001

Pers

ons p

er S

quar

e K

ilom

eter

Popu

latio

n in

Mill

ions

Population Persons per Square Kilometer

Figure 1: Geographical and Administrative Divisions of Nepal

Figure 2: Population Changes During the 90-Year Period, 1911-2001


2


• The sex ratio stood at 96.8 in 1952-54 and at 99.8 in 2001. In 1981, the ratio reached 105, but historically, there have been more women than men in the country.

• Also, the sex ratio has been consistently lower in rural areas, except for the 1971 and 1981 censuses. In the 20-34 age group, there have usually been more women than men, but recently this band has expanded to include the 15-44 age bracket. These trends are consistent with Nepal's tradition of migration. The increase in age bracket with a skewed sex ratio – from 20-34 to 15-44 – shows that the age at which men migrate from Nepal has dropped from 20 to just 15 years, and the age at which they return has increased from 34 to 44. Male migrants generally return home to join their families for retirement.

• The population in central Nepal as a percentage of the country's total population, has increased from 32.68% in 1981 to 34.69% in 2001, mainly due to the high rate of population growth in Kathmandu and surrounding districts, and in central Terai.

• Overall, the central region has the highest population density (293.02 persons per km2), particularly Kathmandu with 2,739 persons per km2; central Terai with 422 persons per km2; and eastern Terai with 454 persons per km2.

• Historically, the country's population has migrated from mountainous and hilly areas towards the Terai. Initially, the plains were covered with dense forest and infested with malaria and other transmissible diseases. Later, with control of diseases and deforestation, Terai became home to 48.43% of Nepal's population in 2001, against 35% in 1954. Fertile agricultural land and employment opportunities are the key reasons leading to this increase in migration.

20 15 10 5 0 5 10 15 20

00-04 05-09 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64

65+

(1971)

Male Female

20 15 10 5 0 5 10 15 20

00-04 05-09 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64

65+

(2001)

Male Female

43.65% 46.66% 48.43%

47.68% 45.53% 44.28%

8.67% 7.80% 7.29%

1981 1991 2001

Terai Hill Mountain

Figure 3: Population Pyramids, 1971 and 2001

Figure 4: Population by Ecological Region


3


• Nepal's population is also migrating from rural to urban areas as people search for more employment opportunities, particularly in Kathmandu.

• The age and gender analysis of the rural and urban areas shows that the concentration of younger population is higher in rural areas as compared to urban areas. However, the percentage of population in the 20-49 age group is highest in urban areas, refl ecting the trend of migration for livelihood/work opportunities.

• The growth in urban population is due to migration from rural to urban areas and an increase in the number of areas classifi ed as urban (from 10 in 1981 to 58 in 2001). Out of the total urban areas, only two are in the mountains.

• The central region (particularly the Kathmandu area) has the highest percentage of urban population, followed by the eastern region.

• In addition to the trend of migration – from rural to urban, and from the hills and mountains to Terai – the number of Nepalese going abroad for employment has also grown with every passing year. According to the Nepal Rastra Bank, 1,394,281 individuals took institutional approval for foreign employment in the period from 2006-07 to 2008-09. Nepal has an emigration rate of 3.9%,4 with 95% of migrants moving to Asian countries, particularly India, Malaysia, Qatar, Saudi Arabia, UAE, Kuwait and Bahrain, among others.5

• The literacy rate in the population aged six and above has increased consistently since 1971. The country's literacy rate was 53.74% in 2001, a signifi cant improvement from 13.9% in 1971. Urban men have the highest literacy rate at 80.90% and rural women have the lowest at 39.32%.

• In 2001, 63.43% of the population was economically active, including 71.68% of men and 55.29% of women, indicating that men are primarily responsible for sustaining households.

• Nepal has experienced a shift in occupations – from agricultural activities to non-agricultural activities. In 1971, 95% of the population was involved in agriculture; this reduced to 65.7% by 2001.

4 Human Development Report 2009.5 Nepal Economic Survey 2008-2009, Nepal Rastra Bank.

24.69% 24.05% 23.08%

32.68% 33.44% 34.69%

20.83% 20.39% 19.74%

13.02% 13.04% 13.01%

8.79% 9.08% 9.47%

1981 1991 2001

Eastern Central Western Mid Western Far Western

6.40% 9.20% 14.20%

93.60% 90.80% 85.80%

1981 1991 2001

Urban Rural

71.6%

50.7% 53.7%

Urban Rural Total Male Female

Figure 5: Population by Development Region

Figure 6: Urban and Rural Population

Figure 7: Literacy Rates and Distribution ofMale/Female Among the Literate Population


4


• The percentage of population engaged in agriculture is much higher in the mountains as compared to the hills and Terai (80.71%, 68.48% and 59.80%, respectively). A higher percentage of population in the Terai is engaged in commerce and manufacturing (11.76% and 10.20%, respectively, in the Terai against 6.19% and 5.32%, in the mountains). The far-western region is the most dependent on agriculture, with 76.76% of the population engaged in agricultural activities and only 5.57% engaged in manufacturing and 6.02% in commerce.

• The percentage of self-employed people has decreased from 85.82% in 1971 to 62.73% in 2001. The last census showed that only 3.8% of the economically active population consisted of employers or entrepreneurs, 24.63% were employed workers and the remaining 8.83% were unpaid family workers.

• In 2001, the unemployment rate was 8.8%.6 According to the Nepal Labour Force Survey, conducted in 2008, unemployment was 2.1% compared to 1.8% in 1998-99. According to the CIA Factbook, unemployment in Nepal was estimated at 46% in 2008.

2.2 POVERTY

Nepal is the poorest country in South Asia and the 12th poorest country in the world.7 According to the 2003-048 Nepal Living Standards Survey, and as it can be observed in Figures 9-11, the overall poverty has decreased signifi cantly from 41.76% in 1995-96 to 30.85% in 2003-04. The survey takes average annual income of NPR 7,696 (USD 105.15) as the national poverty line.

• Poverty remains lowest in the central development region, particularly in the Kathmandu Valley.

6 World Bank Statistics.7 “Poverty in Nepal”, extracted from the World Bank website.8 Unless otherwise noted, all fi gures taken from Nepal Living Standards Survey 2003/04, Central Bureau of Statistics, December 2004.

Mountain

Hills

Terai

65.70%

9.94%

8.81%

6.70%

8.85%

Agriculture, Forestry & Fishing

Commerce

Manufacturing

Personal & Community Services

Others Occupations

Figure 8: Occupations and Segregation by Mountain, Hills and Terai


5


• Poverty increases as we move towards the western region, with far-western and mid-western regions having the highest poverty headcount.

• When looking at the country's geographical regions, poverty used to be highest in mountain areas (57% in 1995-96), but has decreased signifi cantly in recent years. In 2003-04, the hill areas had the highest poverty count at 35%, and Terai had the lowest poverty headcount ratio at 28%. As mentioned earlier, Terai areas rely on diversifi ed sources of income and less on agriculture.

• While poverty has reduced throughout the country, both in 1995-96 and 2003-04, poverty fi gures were higher in rural areas as compared to urban areas, providing further impetus to poor people to migrate to urban areas.

• According to the survey, reduction in poverty can be attributed to migration to urban areas, income from remittances and higher wages in the agriculture sector. In addition, the World Bank explains that the rate of fertility has decreased in Nepal since the 1980s, reducing the size of households and having an impact on poverty.

• Even though absolute poverty has reduced, the Gini Coeffi cient9 has increased from 0.34 in 1992-93 to 0.41 in 2003-04, indicating that the income gap between the poor and the rich has widened.10

9 The Gini coeffi cient is a measure of the inequality of a distribution (commonly used as a measure of inequality of income or wealth), a value of 0 expressing total equality and a value of 1 maximal inequality..

10 Nepal Economic Survey 2009/2010, Ministry of Finance. Government of Nepal.

63.9% 59.9%

38.6% 38.9% 32.5%

4.3%

41.0% 44.8%

27.1% 29.3% 27.1%

3.3%

Far-Western Region

Mid-Western Region

Western Region

Eastern Region Central Region Kathmandu Valley

1995-1996 2003-2004

21.55%

43.27% 41.76%

9.55%

34.62% 30.85%

Urban Rural Total

1995-1996 2003-2004

40% 41%

57%

28% 35% 33%

Terai Hill Mountain

1995-1996 2003-2004

Figure 9: Poverty Headcount Ratio by Development Region

Figure 10: Poverty Headcount Ratio by Rural/Urban

Figure 11: Poverty Headcount Ratio by Ecological Region


6


2.3 HUMAN DEVELOPMENT

• The Human Development Index (HDI) provides a composite measure of human development and includes factors, like life expectancy, education level and per capita income (as an indicator of standard of living).11

• Between 1980 and 2007, Nepal's HDI steadily increased from 0.309 to 0.553; out of 182 countries, Nepal has an HDI ranking of 144. Compared to its HDI ranking, Nepal ranks poorly on the basis of GDP per capita (ranking 165 with GDP per capita at PPP USD 1,049), but is slightly better in life expectancy (ranking 115 with life expectancy at birth being 66.3 years), adult literacy rate (ranking 130 with 56.6% of the population above 15 years of age being literate), and combined gross enrollment ratio (ranking 136 with 60.8% of the population enrolled in primary-, secondary- and tertiary-level education).

2.4 MACROECONOMIC TRENDS 12131415

• The NPR is pegged to the Indian Rupee (INR); therefore, the fl uctuations in NPR to USD rate can be attributed to the changes in INR to USD. According to the International Monetary Fund (IMF), the peg is required to maintain macroeconomic and fi nancial stability.16

• According to the IMF, infl ation trends in Nepal also follow those of India. IMF reports that infl ation in Nepal mirrored that of India up to 2007-08, until loose monetary conditions in 2008-09 caused Nepal to surpass India. Infl ation rate is once again converging with that of India; however, infl ationary pressures remain high in Nepal even as infl ation in India is on the rise.17

11 Human Development Report, 2009: Nepal. Extracted from http://hdrstats.undp.org12 Source: Nepal Economic Survey 2008-09, Fiscal Year 2008/09, Published by Government of Nepal, Ministry of Finance, July 2009.

http://www.mof.gov.np/publication/budget/2009/pdf/english_full.pdf. Exchange rate mentioned is the Annual Average of buying and selling rates, 11 months average of the current fi scal year.

13 Source: Ibid. Annual Infl ation Based on Consumer Price Index. Data for 2008-09 is an estimate calculated using the fi rst 8 months' average. Source for estimates: Economic and Social Survey of Asia and the Pacifi c 2010, Published by United Nations, ESACAP, Economic and Social Commission for Asia and the Pacifi c.

http://democracyforburma.word.press.com/2010/05/11/economic-and-social-survey-of-asia-and-the-pacifi c-2010/.. 14 Source: Ibid. T-bill rates represent the weighted average of the discount rate.15 Source: Ibid.16 IMF Article IV Report, July 2010.17 Ibid.

TABLE 1: MACROECONOMIC INDICATORSIndicator 2004-05 2005-06 2006-07 2007-08 2008-09 2010E*Exchange Rate (NPR to USD)12 72.06 72.32 70.49 65.02 76.84 N/AInfl ation (%)13 4.5 8.0 6.4 7.7 13.2 7.5Treasury Bill Rate (91 days)14 3.94 3.25 2.77 5.13 6.80 N/AInter-bank Lending Rate15 4.71 2.13 3.03 3.61 3.44 N/A* E=Estimate


7


According to the Economic Survey 2009-10, published by the Ministry of Finance, the annual budget targeted an economic growth rate of 5.5% for the fi nancial year 2009-10. However, the target could not be achieved. The survey attributes the failure to the following reasons:

• frequent closures (bandh),

• strikes,

• labour problems,

• shortage/interrupted energy supply, and

• contraction of the external market.

In addition, adverse monsoon conditions affected the agricultural output (with contribution of agriculture in GDP increasing by only by 1% as compared to 3% in the previous year). Agriculture represents a third of Nepal's economy.

2.4.1 STRUCTURE OF THE ECONOMY

• In the past few years, Nepal has become less dependent on agriculture. The share of income from agriculture, as a percentage of GDP, has reduced from 50.9% in 1988 to 33.7% in 2008. This trend can be attributed mostly to the growth in the services industry, which has grown from 32.9% in 1988 to 49.6% in 2008. 18

• The industrial sector's contribution to the GDP in percentage terms has, after a signifi cant spike in 1998, slipped back to the 1988 level (16.2% in 1988 and 16.7% in 2008).

18 Nepal Rastra Bank – Economic Report 2008/09, Published by Nepal Rastra Bank, Research Department,

0%

2%

4%

6%

8%

-

2,000

4,000

6,000

8,000

10,000

2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10

Real GDP in Basic Prices Including Financial Intermediation (Million USD)

Real GDP - Annual % Change

50.9% 39.9% 33.7%

32.9% 37.6% 49.6%

16.2% 22.5% 16.7%

1988 1998 2008

Agriculture Services Industry

Figure 12: Real GDP and GDP Growth

Figure 13: Structure of the Economy (% GDP)


8


2.4.2 THE ROLE OF REMITTANCES IN THE ECONOMY

• Remittances are playing an increasingly important role in the growth of the economy and in reduction of poverty.

• The total amount of remittances, as a percent of GDP, have increased from 10.30% in 2001-02 to an estimated 19% in 2009-10.19

• According to the Nepal Labour Force Survey conducted in 2008, 30% of the enumerated households received remittances. The survey also shows that, last year, the average amount of remittance was NPR 19,721 (USD 269).20

19 Nepal Economic Survey 2009-2010, Ministry of Finance.20 Nepal Labour Force Survey 2008, Central Bureau of Statistics.

Case Study 1: Remittances in Nepal – Vishnu's Family in Hasposa VDC, Sunsari

Vishnu is the father of two girls and lives in a joint family. Three years ago he came back from Kuwait, where he had spent several years working as an electrician. During his stay in Kuwait, Vishnu saved some money, which he used to buy a tractor upon his return to Nepal. Vishnu's family currently has multiple assets and diversifi ed income sources (agriculture, tractor rental, fl ower gardening, a buffalo, and a kirana shop).

When we asked Vishnu where he saves, he mentioned that he had a couple of bank accounts in commercial banks. In addition, Vishnu's wife participates in informal savings groups and is a client of Chhimek Bikas Bank, a microfi nance development bank. However, Vishnu's wife does not know the exact number of groups in which she is a mem-ber. In one of the informal groups, Vishnu's wife saves NPR 100 (USD 1.37) per month and can get a loan of up to NPR 30,000 (USD 410) without collateral and up to NPR 100,000 (USD 1,366) with collateral. Vishnu's daughters also save; they both have a piggy bank, each, and are saving up to buy a bicycle and new clothes.

In the future, Vishnu plans to grow his horticulture business and send his daughters to Kathmandu for higher studies.

10.30% 11% 10.90% 11.10%

14.90% 13.80%

17.50%

21.20% 19%

2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10

Figure 14: Remittance Income as a Percentage of GDP


9


2.4.3 GROSS DOMESTIC SAVINGS

• The Gross Domestic Savings (GDS) at current prices has increased from NPR 43,600 million (USD 596 million) in 2000-01 to NPR 110,751 million (USD 1,513 million) in 2009-10, refl ecting a 15% growth in GDS in comparison to 20.1% growth in the previous year.

• Despite an increase in both consumption and savings, it is estimated that savings will be limited to 9.4% of the GDP, refl ecting a slight decline from 9.8% in the previous year. During the last decade (2000-01 – 2009-10), the GDS declined by 0.13% from the earlier 9.49%. Nepal has one of the lowest GDS in South Asia, compared with Indian GDS in 2008 at 34.3% and the regional average of 17.2%.21

2.4.4 PER CAPITA GDP AGAINST PER CAPITA GROSS DOMESTIC SAVINGS

21 Source: World Bank Statistics as available at http://data.worldbank.org.

9.49% 8.56%

11.75% 11.56% 8.98% 9.82% 9.83% 9.71% 9.36%

2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10

277.91 296.41 318.35 345.54

376.08 412.23 490.03

571.81

25.14 23.79 34.88 36.78 31.00 36.98 40.58 47.67 53.47

2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10

Per Capita GDP (USD) Per Capita GDS (USD)

265.20

Figure 16: Per Capita Income Against Per Capita GDS

Figure 15: Growth in GDS as a Percentage of GDP


10


• With GDP per capita increasing over time, consumption is increasing at a faster rate than savings. This trend continues even during periods of low economic growth.

• According to the Economic Survey 2008-09, conducted by the Ministry of Finance, millions of Nepalese youths are going overseas due to dearth of employment opportunities in the country, and thus the amount of remittances being sent to relatives in Nepal is increasing. However, a large portion of these remittances is being spent on consumption items and imported consumer goods, as well as on purchase of real-estate. Therefore, the growth of remittances has not yet been refl ected in a higher fi nancial savings rates.

2.5 DOING BUSINESS IN NEPAL

Nepal ranks 123 out of 183 countries on 'Ease of Doing Business'. The country has a ranking of 87 for starting a business, 148 for employing workers, 113 for getting credit, 73 for protecting investors, 124 for paying taxes, 161 for trading across borders, 122 for enforcing contracts and 105 for closing businesses.

According to an Enterprise Survey, conducted in 2009, more than 60% of fi rms reported political instability as their greatest obstacle in conducting business in the country, and almost 30% reported electricity problems as the main constraint. Other fi rms (less than 5% for each of the following factors) reported labour regulations, access to fi nance, transportation and inadequately educated workforce as their greatest obstacles in conducting business. In addition, the country ranks 149 in regulatory quality and 143 in control of corruption.22

In its Economic Survey Report 2009-10, even the Ministry of Finance recognises that the business environment is not conducive for attracting investors. This hinders growth in industries such as agro-processing, high-value herbs processing, tourism, hydropower, education and health, thus affecting the country's GDP.

3. LEGAL AND REGULATORY FRAMEWORK AND FINANCIAL INFRASTRUCTURE

The fi nancial sector in Nepal is governed by the Banks and Financial Institutions Act (BAFIA), 2006. The Financial Intermediary Societies Act, 1999 and the Co-operatives Act, 1992 regulate the non-banking fi nancial intermediaries: fi nancial intermediary non-governmental organisations (FINGOs) and savings and credit co-operatives (SACCOs), respectively. The Nepal Rastra Bank Act, 2002, entrusted the regulatory responsibility of the fi nancial sector with Nepal Rastra Bank – the central bank of Nepal. The regulatory responsibility of the insurance sector lies with the Insurance Board and is governed by the Insurance Act, 1993.

Nepal's formal fi nancial sector has both banking and non-banking sectors. Banking sector comprises of Nepal Rastra Bank (NRB) and class A commercial banks (CB). The non-banking sector, includes class B development banks, class C fi nance companies, class D microcredit development banks (including the fi ve Grameen Bikas banks), SACCOs with

22 Business Environment Snapshot, Nepal. Published by the World Bank.


11


limited banking license, and FINGOs performing limited banking activities and other fi nancial institutions, such as insurance companies, Employees' Provident Fund, Citizen Investment Trust, postal saving offi ces and the Nepal Stock Exchange.

The semi-formal sector primarily includes savings and credit and other types of co-operatives registered with the Department of Co-operatives (but not licensed by NRB). Co-operatives in Nepal are single or multipurpose, with single purpose co-operatives, including small farmer, dairy, agriculture, and electricity, among others. The informal sector is characterised by informal groups, essentially associations of people who pool their savings funds to extend credit to their members, such as Dhikuti groups. Moneylenders, traders, friends and relatives are also part of the informal sector.

3.1 FORMAL INSTITUTIONS FOR DEPOSIT MOBILISATION IN NEPAL

Nepal's banking system has grown rapidly during the last two decades. The economic liberalisation policy, particularly the liberalisation of the fi nancial sector in 1980, paved the way for establishment of new banks and non-bank fi nancial institutions in the country. Consequently, by the end of July 2009, 26 banks and 216 non-bank fi nancial institutions, licensed by NRB, were in operation. Out of them, 26 were class A commercial banks, 63 were class B development banks, 77 were class C fi nance companies, 15 were class D microcredit development banks, 16 were savings and credit co-operatives and 45 were fi nancial intermediary NGOs licensed by the NRB. Postal banks and insurance companies also comprise the formal sector. NRB offi cials note that they have stopped issuing limited licenses for SACCOs and FINGOs until further notice.

10

13

17

18

20

25

26

4

7

26

28

38

58

63

21

45

60

70

74

78

77

4

7

11

11

12

12

15

6

19

20

19

16

16

16

7

47

47

46

46

45

1995

2000

2005

2006

2007

2008

2009

Figure 17: NRB Licensed Institutions

Commercial Banks Development Banks Finance Companies

Microcredit Development Banks Savings and Credit Co-Operatives NGO Financial Intermediaries


12


3.1.1 FINANCIAL SECTOR REGULATION IN THE FORMAL SECTOR AND ROLE OF NRB

The summary of regulations and regulators associated with each form of institution are specifi ed in Table 2.

TABLE 2: SUMMARY OF REGULATORS AND APPLICABLE ACTS IN THE FORMAL FINANCIAL SYSTEM IN NEPALInstitution Type Regulated by Applicable ActsCommercial Banks (Class A)

• Nepal Rastra Bank• Registrar of Companies

• Banking and Financial Institutions Act, 2006• Companies Act, 1991• Nepal Rastra Bank Act, 2002

Development Banks (Class B)Finance Companies (Class C)Microcredit Development Banks (Class D)Savings and Credit Co-operatives (SACCOs)

• Nepal Rastra Bank• Registrar of Co-operatives

• Co-operative Act, 1992• Nepal Rastra Bank Act, 2002

Non-Governmental Organisations(FINGOs)

• Nepal Rastra Bank• Chief District Offi cer/ Registrar of Co-operatives

• Registration of Associations Act, 1977• Financial Intermediary Societies Act, 1999

Postal Offi ce Savings Bank • Government of Nepal • Post Offi ce Savings Bank Regulation, 1976

Insurance Companies • Insurance Board • Insurance Act, 1992

The Nepal Rastra Bank (NRB) was established in 1956 under the Nepal Rastra Bank Act, 1955. A new Act in 2002 recast the functions and objectives of the NRB in light of the growth in the number of institutions and scope of activities in the fi nancial sector. According to the Nepal Rastra Bank Act, 2002, the NRB is entrusted with carrying out the functions of a central bank and has the responsibility of licensing, monitoring and guiding the fi nancial sector in Nepal. The objectives of establishing the central bank are as follows:

• To formulate the necessary monetary and foreign exchange policies in order to maintain and manage the stability of prices and the balance of payment for sustainable development of the economy;

• To promote stability and liquidity required in the banking and fi nancial sector;

• To issue bank notes and coins;

• To develop a secure, healthy and effi cient system of payments;

• To license, regulate, inspect, supervise and monitor the banking and fi nancial system;

• To promote the entire banking and fi nancial system and to enhance its public credibility; and

• To extend co-operation in the implementation of economic policies of the Government of Nepal.23

23 Nepal Rastra Bank Act, 2002.


13


The Banks and Financial Institutions Act (BAFIA) regulates commercial banks, development banks, fi nance companies and microcredit development banks in Nepal. BAFIA is an amended and consolidated version of all the fi ve prevailing legislations24 relating to banks and fi nancial institutions. The Act consolidates provisions relating to the establishment, operation, management and regulation of banks and fi nancial institutions. BAFIA classifi es the licensed banking institutions into:

• Class A - Commercial Banks (CB)

• Class B - Development Banks (DB)

• Class C - Finance Companies (FC)

• Class D - Microcredit Development Banks (MDB)

The classifi cation is based on the minimum paid-up capital. The minimum paid-up capital for the licensed institutions prescribed by NRB is given in Table 3. 2526

The Act also outlines regulations regarding the process for incorporation and licensing of banks and fi nancial institutions and securities:

• The management (board of directors and chief executive) of banks and fi nancial institutions;

24 In the absence of parliament, an integrated Banks and Financial Institutions Ordinance, 2003 was enacted repealing fi ve Acts: Agricultural Development Bank Act, 1967, Commercial Bank Act, 1974, Finance Company Act, 1985, Nepal Industrial Development Corporation Act, 1990 and Development Bank Act, 1996. The ordinance converted to Banks and Financial Institutions Act with effect from August 01, 2006.

25 Directive issued by NRB, E.PRA.Nridheshan No. 21/06726 In addition to the 10 districts, MDB can also operate in 5 hill districts.

TABLE 3: MINIMUM PAID-UP CAPITAL REQUIREMENT FOR FINANCIAL INSTITUTIONS (IN MILLIONS)25

Category of Financial Institution Operational BoundariesNational Regional 4 – 10 Districts 1 – 3 Districts

A. Commercial Banks NPR 2,000 (USD 27.33)

B. Development Banks > With leasing business NPR 640

(USD 8.74)NPR 300

(USD 4.10)NPR 300

(USD 4.10) > Without leasing business NPR 640

(USD 8.74)NPR 200

(USD 2.73)NPR 100

(USD 1.37)C. Finance Companies > With leasing business NPR 300

(USD 4.10)NPR 300

(USD 4.10) > Without leasing business NPR 200

(USD 2.73)NPR 100

(USD 1.37)D. Microcredit Development Banks

NPR 100(USD 1.37)

NPR 60(USD 0.82)

NPR 2026

(USD 0.27)NPR 10

(USD 0.14)


14


• Classifi cation of licenses;

• Capital requirements;

• Permitted fi nancial transactions by each class;

• Power to regulate, inspect and supervise by NRB;

• Provisions relating to supply and recovery of credit;

• Maintenance of accounts, records, returns and reports; and

• Provisions relating to mergers and liquidation.

The scope of activities allowed for each type of fi nancial institution is summarised i n Table 4.27

27 Table has been prepared based on information extracted from the Bank and Financial Institutions Act, 2006, Co-operative Act, 1992, Financial Intermediary Societies Act, 1999 and Unifi ed Directives 2067 (July 2010).

TABLE 4: SCOPE OF ACTIVITIES ALLOWED TO EACH TYPE OF FORMAL FINANCIAL INSTITUTION27

Class A Class B Class C Class D SACCOs FINGOsAccept/refund deposit (with or without interest)

√ √ √ √ § √ § √ §

Offer credit with or without collateral √ √ √ √ § √ § √ §Offer credit for leasing and hire purchase, housing fi nance √ √ √ NM NM NM

Hypothecation √ х х NM NM NMProvide over draft facility √ √ √ NM NM NMAppoint agents √ √ NM NM NM NMIssue debit/credit cards √ √ NM NM NM NMInstall ATM/cash dispensing machines √ √ √ NM NM NMAccept/transfer/payments through electronic medium

√ √ NM NM NM NM

Deal in foreign exchange √ √ √ ‡ NM NM NMPurchase and sale of gold and silver bullion, shares, debentures, bonds for itself or on behalf of its customers.

√ √ √ NM NM NM

Work as an agent of CBs and other fi nancial institutions NM NM NM NM NM

√

Extension counters √ √ √ х х хBranchless / mobile branch banking √ √ х х х х

NM = Not mentioned. § = From members only; In the case of class D institutions, they can accept deposits from non-members after obtaining prior approval from NRB. ‡ = INR only.


15


3.1.2 COMMERCIAL BANKS (CLASS A)

Banking, in the modern sense, started with the inception of Nepal Bank Limited (NBL) on November 15, 1937 under the Nepal Bank Act, 1937. NBL was the fi rst commercial bank of the country, accepting deposits, giving loans and rendering other banking services to the public, as well as acting as a bank to the government. In 1956, Nepal Rastra Bank was established and the second commercial bank, Rastriya Banijya Bank (RBB) was set up in 1966 as a fully government-owned commercial bank.

In July 2009, there were 26 commercial banks in Nepal.28 Class A banks are allowed to enter into the widest scope of activities (refer to Table 4) and are therefore, subject to stricter regulations and supervision by the NRB. The minimum paid-up capital requirement for obtaining a license under this category is NPR 2,000 million (USD 27.33 million). Until recently, once a class A bank was established, no limitations were applied to it as far as expansion was concerned. However, since this fi scal year (2010-11), certain restrictions have been imposed, for instance, for each new branch to be opened within the Kathmandu Valley, the bank must open one branch outside the Kathmandu Valley.29

3.1.3 DEVELOPMENT BANKS (CLASS B)

Many development banks have been set up through active participation of the private sector after the Development Bank Act, 1996, came into effect. The main objective of the Act was to enhance agriculture, industry and commerce by extending credit facility to the public. Prior to this Act, there were only two government-owned development banks: Agricultural Development Bank (which was converted into a commercial bank in 2006) and Nepal Industrial Development Corporation. At present, development banks operate under BAFIA, 2006, and are classifi ed as class B fi nancial institutions. NRB is the regulatory authority for development banks.

The minimum paid-up capital requirement for obtaining a national license under class B category is NPR 640 million (USD 8.74 million), and lower minimum capital requirements apply according to the number of districts to be covered, as detailed in Table 3. Out of 63 development banks, 11 operate at the national level and the rest are district-level development banks. Table 4 shows the scope of activities allowed to them.

3.1.4 FINANCE COMPANIES (CLASS C)

Finance Companies (FCs) are also registered as public limited companies under the Offi ce of the Company Registrar and are governed by the Finance Company Act, 1985. The Finance Company Act was issued as part of the liberalisation process in Nepal in the 1980s to promote the establishment of banking institutions with a lower capital requirement. Later, FCs were brought under the purview of BAFIA, 2006, and classifi ed as class C entities.

28 Banking and Financial Statistics No.53, Nepal Rastra Bank, Mid-July 2009.29 Directive No.14/067 Unifi ed Directives 2067Bai.Bi.Ni.Bi./Niti/Paripatra/50/066/67 dated 16 July 2010.


16


Finance companies can also be established at a national or district level and the minimum paid-up capital requirement depends on the geographic coverage (see Table 3). The activities that can be taken up by fi nance companies are more restricted when compared to class A and class B institutions, with a prohibition on hypothecation and permission to deal only in Indian Rupees and not in other currencies. Recent directives have allowed fi nance companies to install ATM/cash dispensing machines.30 Though fi nancial companies are allowed to open extension counters, they cannot offer branchless banking services.

3.1.5 MICROCREDIT DEVELOPMENT BANKS (CLASS D)

Microcredit development banks (MDBs) are registered as public limited companies under the Offi ce of the Company Registrar. These companies are licensed under BAFIA, 2006, and classifi ed as class D entities. The minimum paid-up capital requirement for obtaining a license under category D is the lowest out of the classifi ed institutions and varies according to the reach of the institution, whether it will be set up at the national, regional or district level (see Table 3). If permission is granted to work in 1-10 districts, MDBs can also work in fi ve additional hill districts without infusing additional capital. According to the Monetary Policy of 2007-08, MDBs are allowed to expand, but they have to infuse an incremental paid-up capital of NPR 2.5 million (USD 22,124), over and above the initial paid-up capital, for every additional adjoining district. The provision was intended to expand fi nancial services in rural areas and to give MDBs avenues for expansion.31

Class D institutions include the fi ve regional rural development banks established by the NRB between 1992 and 1996 to extend fi nancial services to the rural population in each of the fi ve development regions. The scope of activities allowed for MDBs is summar ised in Table 4.

In an attempt to increase deposit mobilisation in the country and improve liquidity for class D institutions, NRB recently issued a directive32 whereby MDBs can seek permission from NRB to mobilise deposits from the general public, i.e. from non-members. Under this provision, MDBs can only offer savings and fi xed deposits with tenor of up to two years. In order to obtain such permission, MDBs must comply with the specifi ed criteria, including, but not limited to, showing profi tability for the last three years; fulfi lling all directives issued by the NRB; amending Memorandum and Articles of Association to include deposit mobilisation services from the general public; having policies for deposit, credit and mobilisation of funds in place; having non-performing assets of less than 5%; and having at least 2,500 members.

3.1.6 FINANCIAL INTERMEDIARY NON-GOVERNMENTAL ORGANISATIONS (FINGOS)

FINGOs are societies registered under the Associations Act, 1977. Seven or more members can jointly apply to the district authority to register as a society. Societies that have three years experience in the social sector and have specifi ed microfi nance in their object clause can apply to NRB for a limited banking license. Having this license enables them to take up fi nancial intermediation by providing microcredit to low-income people to improve

30 Directive No.21/067 Unifi ed directives 2067). Bai.Bi.Ni,Bi/niti/paripatra/50/066/67/ dated 2067.3.32/16 July 2010-09-14 Monetary Policy 2007/2008, Nepal Rastra Bank, July 2007. 31 Monetary Policy 2007/2008, Nepal Rastra Bank, July 2007. 32 Directive No.16/067 (Unifi ed directives 2067); Bai.Bi.Ni,Bi/niti/paripatra/50/066/67/dated 2067.3.32/16 July 2010

“...to increase deposit mobilisation in the country and improve

liquidity for class D institu-

tions, NRB has recently

issued a directive whereby

MDBs can seek permission

from NRB to mobilise

deposits from the general

public, i.e. from

non-members."


17


their economic condition. Only societies with a limited banking license from NRB can start fi nancial intermediation. NRB is required to conduct necessary enquiries and issue the license within 75 days from the date of application. The license must be renewed every two years. In mid-July 2009, there were 45 FINGOs licensed by the NRB.33

The minimum capital requirement for setting up a FINGO is NPR 100,000 (USD 1,366), which consists of membership fees, reserves and capital grants. Non-government organisations with at least 500 members in the Kathmandu Valley and Terai, and 300 in other districts (and with least 50% women members), can apply for a fi nancial intermediation license. FINGOs can apply to the NRB for authorisation to expand into adjoining districts. Usually, the NRB will allow expansion into one district per fi scal year; however, FINGOs can apply for more districts and the NRB will grant the permission based on its evaluation of the proposal, business plan and fulfi lment of minimum requirements, including NPA and repayment rate.34

FINGOs are authorised to encourage low-income people to form groups; to provide microcredit to any group or member thereof for operating microenterprises, with or without collateral; to mobilise deposits from members; to provide training and organise workshops to improve entrepreneurial skills; and to work as agents of commercial banks and other fi nancial institutions. Full or partial income tax exemption on the income earned by the society is available.

3.1.7 SAVINGS AND CREDIT CO-OPERATIVES (SACCOS) WITH LIMITED BANKING LICENSE

SACCOs are community-based fi nancial institutions that are owned and controlled by the members. A co-operative can be registered if 25 members submit an application with the required documents to the Registrar of Co-operatives. A society or union may accept savings deposits only from its members and also offer loans to them. Citizens of Nepal, who reside within the jurisdiction of the co-operative society, and who want to avail its services, can obtain membership by buying shares. SACCOs are governed by the Co-operative Act, 1992, rules set in the by-laws of the institution and by the seven principles of co-operatives: (1) open and voluntary membership, (2) democratic member control, (3) member's economic participation, (4) autonomy and independence, (5) education, training and information (6) co-operation among co-operatives and (7) concern for the community.

The Co-operative Act, 1992, outlines details about the formation and operation of co-operative societies and unions of different categories. The Act governs the formation, registration, membership and working procedures of SACCOs (among others). SACCOs were established to enable farmers, artisans, low-capital and low-income groups, labourers, landless and unemployed people, or social workers of the country to work for the economic and social development of the general consumers on the basis of mutual co-operation.

33 Source:http://brf.nrb.org.np/List_Bank_n_Non_Banks.htm34 Based on discussion with Mr. Bhopal Prasad Kaphle, Executive Director, Microfi nance Supervision and Promotion Department,

Nepal Rastra Bank.


18


A society must obtain the prior approval of NRB in order to engage in banking business. Licensed SACCOs should comply with the conditions prescribed and the directives issued by NRB. The limited banking license does not carry with it any right to generate deposits from non-members. Licensed co-operatives have used this recognition from the NRB to demonstrate their fi nancial soundness to the general public and, thereby, to fuel increase in membership and deposits.

NRB directives indicate the following requirements for co-operative societies holding a limited banking lice nse:35

• Share capital requirement, as outlined in Table 5.

TABLE 5: SHARE CAPITAL REQUIREMENT FOR LICENSED SACCOSType of Offi ce Share Capital RequirementOffi ce in metropolitan district and is operating within a district NPR 10 million (USD 136,631)Offi ce in sub-metropolitan district and is operating within a district NPR 5 million (USD 68,315)Offi ce in municipality district and is operating within a district NPR 2.5 million (USD 34,158)Offi ce in other places and is operating within a district NPR 1 million (USD 13,663)

• Limit its operations to one district only. As per the new directive issued by the Registrar of Co-operatives in August 2010, SACCOs can request permission from the Registrar for expansion in up to fi ve adjoining districts. The Registrar may grant the permission at its discretion and based on fulfi lment of the specifi ed criteria. 36

• Collect deposits or advances from members up to 10 times the core capital.

• Collect savings, deposits and term-deposits with a maximum tenure of three years.

• Maintain 1% of total deposits and advances with NRB.

• Maintain 7% of total deposit liability as liquid assets, with 2% as cash in vault or in a current account in any commercial bank.

• Determine interest rates and service fees by the Board of Directors at their discretion, and inform NRB's non-banking management division of any changes by written notice.

SACCOs are required to maintain updated records of its meetings and accounts, and submit an annual report on its business to the Registrar of Co-operatives. The report should contain policies and plans fi nalised with respect to the distribution of savings, names of directors and their remaining term, the date fi xed for meetings of the general assembly, and other particulars prescribed by the Registrar from time to time.

35 Directive to Co-operative Societies Holding a Limited Banking Transaction License, Enacted in 2002. Available at: http://www.cgap.org/p/site/c/template.rc/1.1.5981/

36 Discussion with Mr, Madhab Prasad Paudyal, Manager at VYCCU SACCOs


19


3.1.8 POST OFFICE SAVINGS BANK

In Nepal, the Post Offi ce Savings Bank (POSB) was set up as a deposit mobilisation agency to cultivate the habit of saving among ordinary people by mobilising small amounts. POSB was established under the general guidance of the Post Offi ce Savings Banks Regulations, 1976, to offer banking services to the rural population, which does not have access to bank branches. The POSB initially started operations in four district post offi ces. Presently, there are 117 POSBs in Nepal: 70 district post offi ces, four regional postal directorates, one general post offi ce and 42 area post offi ces. Of these, only 58 post offi ces have the permission to invest savings mobilised through NPR 50,000-100,000 (USD 442-884) loans to employees of the Ministry of Information and Communication at an interest rate of 10% per annum. The POSBs, which are not permitted to invest savings, are required to remit 10% of their deposits to the Central Money Order offi ce and the remainder to selected fi nancially sound commercial banks.37

Post Offi ce Savings Bank Regulation, 1976, outlines the procedures for opening a POSB, formation and functions of the Post-Offi ce Savings Bank Advisory Committee, products offered, procedures to open accounts, deposits, withdrawals and functions and duties of the POSB. Administration and operation of POSBs is also regulated by the Post Offi ce Operations Manual, 2003, and the Post Offi ce Savings Bank Investment Manual, 2003.

POSBs offer two types of accounts with similar terms and conditions: one general account which pays 7% interest per annum, and an elderly citizen's account for people who are over 70 years old, which pays 8% per annum. Currently, POSBs have an approximate outreach of 40,000 accounts with a savings balance of about NPR 1 billion (USD 13.7 million).

3.1.9 CITIZEN INVESTMENT TRUST (NAGARIK LAGANI KOSH)

The Citizen Investment Trust (CIT) was incorporated on March 18, 1991 under the Citizen Investment Trust Act, 1990, in order to expand investment opportunities by encouraging the general public to save and by bringing dynamism into the development of capital markets in the country. The main objectives of CIT are: to help small and medium savers by providing them opportunities to benefi t from the capital markets; to expand the social security coverage by providing a pension scheme; to develop a base for institutional investors in the securities market (creating long-term pension and mutual funds available for investment); and to provide the services as a debenture trustee for the management of secured debentures.

CIT's services, include savings mobilisation through gratuity funds, pension funds, insurance funds and mutual fund schemes; investment in corporate shares, debentures and government securities; fi nancing corporate bodies; providing loans for purchasing shares; and capital market services, which include debenture trustee services, underwriting of public issues and consultancy services.

37 The Evolution of Post-offi ce Savings Bank in Nepal by Shree Dhar Gautum. Chapter IX, Nepalese Financial Systems–Growth and Challenges


20


3.1.10 EMPLOYEES' PROVIDENT FUND (KARMACHARI SANCHAYA KOSH)

The EPF was established under the Karamachari Sanchaya Kosh (Employees' Provident Fund) Act, 1962. The primary objectives of Karamachari Sanchaya Kosh (KSK) are to mobilise savings through the compulsory provident fund contribution from employer and employee and to manage the fund in order to help the benefi ciaries at the time of retirement. Until 1978, the EPF coverage was limited to the government and semi-government organisations, but later it was extended to cover the teaching staff at both public and private schools, and other employees at schools, universities, diplomatic missions and non-governme nt al organisations employing more than 10 people.

TABLE 6: NUMBER OF CONTRIBUTORS TO EPFArea Number of ContributorsCivil (Government Organisations) 88,000Nepal Army 91,000Nepal Police and Nepal Armed Police 78,000Private Organisations, Corporate Sector 95,000Education 88,000Total 440,000

Currently, EPF's membership is 440,000 members (2.5% of the total active population). Members are required to contribute at least 10% of their salary to their EPF account, and employers are required to match the employees' contributions. The EPF provides additional benefi ts to its members, including accident indemnity, funeral grants, insurance and special loans. The breakdown of contributors in the year 2010 is shown in Table 6.38 The interest rate offered on EPF deposits in the year 2010-11 is 8%.39

3.2 SEMI-FORMAL INSTITUTIONS FOR DEPOSIT MOBILISATION IN NEPAL

SACCOs registered under the Co-operative Act and societies (non-government organisations) registered under the Societies Act are involved in mobilising deposits in Nepal. Those institutions which do not have a limited license from the NRB are considered to be a part of the semi-formal sector.

SACCOS are owned and managed by members. Under the Co-operative Act, SACCOs are permitted to mobilise savings from members and offer credit facilities to them. According to the Nepal Federation of Savings and Credit Co-operative Unions Ltd. (NEFSCUN) there are more than 6,000 SACCOs in the country.40 Many of them are inactive, closed or just exist on paper. Seven-hundred-and-thirty organisations (34 district unions and 696 SACCOs) are direct members of NEFSCUN and another 700 are indirect members through district unions.41 Only 16 SACCOs are registered with the NRB for a limited banking license.

38 http://nlkosh.org.np/39 The Board of Directors of EPF fi x the rate of interests on PF deposits while considering the total PF Deposit, total investment, total

interest or dividend received from investments and administrative expenses.40 Excerpts from the expert interview with NEFSCUN senior management.41 As per Clause 2 of The Co-operative Act, 1992: Five Single-Purpose Primary Co-operatives can form a Single-Purpose Co-operative

Union, and 5 Multi-purpose Primary Co-operatives or 5 Single-Purpose Co-operative Unions can form a District Co-operative Union. Five Single-Purpose Co-operative Unions or 25 Single-Purpose Primary Co-operatives can also form a Single-Purpose Central Co-operative Union. Finally, a National Co-operative Federation can be formed by 15 District Co-operative Unions, Single-Purpose Co-operative Unions, and Single-Purpose Central Co-operative Unions.


21


As per the regulations, all SACCOs must be members of either the District Union or the Federal Union. However, most SACCOs do not have a membership, as they do not see value in associating with federated structures at either the district or national level. Other types of co-operatives can also take deposits and give loans to their members. According to the unoffi cial data provided by the Department of Co-operatives, there are 12,646 co-operatives in Nepal (as on April 15, 2009). A pictographical break-up of different types of co-operatives has been given in Figure 18.

3.3 INFORMAL INSTITUTIONS FOR DEPOSIT MOBILISATION IN NEPAL

The informal sector is comprised of about 20,000 informal community-based organisations, such as self-help groups and the ROSCAs, together known as Dhukuti. The term originates from the Nepali word dhukuti, which means a storage box used for valuables or food grains. A Dhikuti is a fi nancial self-help group which originated from a system of communal food grain storage for the needy. With the onset of the market economy, Dhikutis expanded quickly and became an informal people's bank, providing capital for small businessmen as well as farmers. Its resources are solely derived from internal savings mobilisation. A Dhikuti can be defi ned as a rotating credit association in which equal amounts of money are collected from the participants at regular intervals and allocated to one member at a time. The rotation is determined mostly by secret tender with the funds going to the lowest bidder, except at the fi rst and last rounds. Most Dhikuti groups are formed by 10 to 30 members, with open access to both men and women. The cycle of rotation is usually semi-annual and annual for smaller groups. Members are usually fi ned for not attending a meeting and each group has a founder and an administrator. Default within these groups normally remains low.42

There are also a large number of other informal groups, like unregistered co-operatives. In addition, moneylenders, traders and friends are also the other informal sources of fi nance. Friends and family are the main providers of informal loans in both urban and rural areas. Within informal groups, there are various community groups, including: mothers' groups, women's groups, farmers' groups, veterinarians', teachers', retired army personnel, community forestry and microentrepreneurs' groups.

The rates charged by moneylenders for borrowing is around 36% per annum (fl at), whereas informal groups charge 18-24% per annum (declining balance). Local NGOs pay interest rates ranging from 8-12% on the savings they mobilise. However, instead of paying interest on deposits in cash, informal groups usually add the interest earned on borrowings to the depositor's account(s) at the end of the year.

3.4 INSURANCE SECTOR

The insurance sector in Nepal is regulated by the Insurance Board and is governed by the Insurance Act, 1993. The Insurance Board is an autonomous corporate body constituted

42 Source: http://www.gdrc.org/icm/dhikuti.html

Savings and Credit 5,162

Multipurpose 2,978

Dairy 1,603

Agriculture 1,736

Electricity 257

Others 910

Figure 18: Number of Co-operatives in Nepal by Category (April 2009)


22


to systemise, regularise, develop and regulate the insurance system. According to the Act, three categories of services can be offered by an insurer: life, non-life and reinsurance.

The Board is the licensing authority for the insurer, insurance agent, surveyor and broker. It also frames the policies for making investments and acts as the arbitrator in disputes between the insurer and the insured. The license to do insurance business must be renewed every year through a renewal fee. An insurance company has to assess its fi nancials and have its liabilities valued by an actuary once every three years and submit this report to the Board. Insurance companies in Nepal are required to deposit funds as per the liabilities of conducting insurance business within Nepal.43

At present, there are no insurance companies providing reinsurance services in the country. Local companies depend on overseas insurance companies for reinsurance by paying a reinsurance premium to cover their liabilities. Given the situation, the Insurance Board (IB) has been making efforts to establish a reinsurance company as the country´s insurance market has already matured and grown to a formidable size. The Board has already incorporated the provisions related to the establishment of a reinsurance company in the draft of the new Insurance Act. Based on the fi ndings of the IB, the government had announced in its budget for the year 2008-09 that it would grant an operating license for a reinsurance company in the country. Despite these efforts, a reinsurance company is yet to be established.

The records of the IB show that general insurance companies, in the absence of local reinsurance coverage, are currently transferring as much as 98% of their premium to reinsurance companies abroad to cover their risks. In case of life insurance, about 20% of the total mobilised premium is sent abroad to pay for reinsurance.44

43 The insurer shall deposit the following amounts in the reserve fund for the liabilities of its insurance business within the Kingdom (now Republic) of Nepal: (i) An amount not less than the total liability as specifi ed by the actuary on the basis of the insurance policies issued by the insurer for the life insurance business, (ii) An amount not less than fi fty percent of the net insurance premium shown in the income and expenditure of the non-life insurance business, (iii) Fifty percent of the profi t earned until the amount equals the paid-up capital of the insurer operating the non-life insurance business, (iv) An amount of one hundred fi fteen percent of the balance amount of payment against claims made on the insurer before the expiry of each fi scal year.

44 http://www.myrepublica.com/portal/index.php?action=news_details&news_id=21375

Life

Insu

ranc

e

Re-

Insu

rean

ce

•Re-insurance companies (though re-insurance compa-nies have not yet been regis-tered in Nepal)

Non

-Life

Insu

rean

ce

•Whole Life Insurance•Endowment Life Insurance•Term Life Insurance

•Fire Insurance•Motor Insurance•Marine Insurance•Aviation Insurance•Engineering and Contractor's Risk Insurance•Miscellaneous Insurance

Insurance

Figure 19: Types of Insurance in Nepal


23


3.5 QUALITY OF SUPERVISION

According to NRB offi cials, the central bank has two departments for supervising. The fi rst department is in-charge of supervising commercial banks, and the second one is in-charge of other fi nancial institutions, including class B, C, D, limited licensed SACCOs and FINGOs. As on June 2010, class A commercial banks had been visited once a year, while other fi nancial institutions were visited once every two years. However, the staffi ng of the two units seems disproportional: the unit in charge of the supervision of 27 commercial banks is staffed with nearly 60 persons, whereas the unit in charge of all other fi nancial institutions (roughly 200) is staffed with only 50 persons.

In addition to the on-site visits, the NRB conducts off-site supervision by analysing monthly reports from institutions on key balance sheet and income statement fi gures, as well as ratios, including capital fund, credit-to-deposit ratio, cash reserve requirement (CRR), and statutory liquidity ratio (SLR). However, leading bankers and microfi nance experts are of the opinion that while NRB's on-site supervision is good, their off-site monitoring is not effective and that NRB needs to be strengthened in terms of its capacity and skills. As one leading expert noted, “NRB doesn't have the expertise or capacity to supervise...they only reach some of the institutions once in three years”.

There is widespread concern that the recent directive to enable MDBs to take deposits from the public will further stretch the resources and capacity of the regulatory authority. The NRB is aware of some of its weaknesses and is hoping that some of the problems will be resolved once the second tier institution (STI) is established and empowered to regulate and supervise class D MDBs, limited license SACCOs and FINGOs.

With regards to non-licensed SACCOs and other co-operatives, even though there are attempts to strengthen the co-operative sector and guidelines and standards have been developed, the Registrar of Co-operatives does not have the capacity to enforce them. Currently, the Offi ce of the Registrar does not have the manpower for supervision. According to Mr. Sudarsan Dhakal, Registrar of Co-operatives, they would need at least 60 employees, with graduate degrees to monitor 30 to 50 co-operatives in a year, but they only have 8. In addition, the Registrar recognises that the existing staff is weak. Of the 8 staff members in the Registrar's offi ce, only one is an offi cer and the others are junior level staff. The Co-operative Department also faces challenges due to high staff turnover (as government staff is rotated every two years) and budget constraints. The Registrar believed that an independent co-operative authority would solve some of the problems; at the very least, it would reduce the rotation of staff. Other experts added that NEFSCUN does play a supervisory role with their SACCOs members, but overall they are also weak in terms of capacity.

3.6 GOVERNMENT DEVELOPMENT INITIATIVES IN MICROFINANCE

Historically, the Government of Nepal has been very active in promoting fi nancial services in the country. In 1974, the NRB formulated a policy to enable provision of institutional credit to the poorest sector of the economy and directed all commercial banks to compulsorily

“NRB doesn’t have the expertise or capacity to

supervise...they only reach

some of the institutions once

in three years”.

- Leading microfinance expert


24


lend at least 5% of their deposit liabilities to the poor. The policy later evolved into the existing “deprived sector lending” (explained below).

In addition, the NRB played an important role in building the rural fi nancial system through equity investments in several institutions, including the Nepal Industrial Development Corporation (NIDC) in 1959 and the Agriculture Development Bank of Nepal (ADB) in 1968. In 1992, based on the Grameen Bank model of Bangladesh, the government established two regional rural development banks (RDBs) with majority shareholding from the NRB (66.75% and 58.5%), one in each of the eastern and far-western development regions. By June 1996, three RDBs, one in each of the other three development regions, had also been established. However, these initiatives were focused on the spread of microcredit rather than microsavings. 45 Later on, the Government identifi ed the need to create a platform to enable institutions to mobilise microdeposits, and, accordingly, the legal structure for MDBs was created under the purview of NRB, and later on FINGOs were also authorised to mobilise savings.

3.6.1 DEPRIVED SECTOR LENDING

To ensure credit opportunities for the poorer sections of the population (including microfi nance clients), Nepal Rastra Bank has imposed “deprived sector lending” requirements on commercial banks, development banks and fi nance companies. The deprived sector includes low-income and socially backward women, tribes, lower caste, the blind and hearing impaired and physically handicapped persons, marginal and small farmers, craftsmen, labourers and landless families.

Licensed institutions in class A, B and C are required to lend at least 3%, 2% and 1.5% of their total outstanding loans and advances to the deprived sector.46 Institutions may achieve the targets prescribed for reaching the deprived sector either by lending directly to the end user or through loan or equity support to other microfi nance institutions.

Class A, B and C institutions willing to extend credit to the deprived sector are also permitted to establish a separate class D microcredit institution as a subsidiary. The promoters' share in the ownership of subsidiary company can be a minimum of 51% and a maximum of 70% of the paid-up capital. A minimum of 30% of the shares should be offered to the public.47

3.6.2 NATIONAL MICROFINANCE POLICY 2008

The Government of Nepal has issued the National Microfi nance Policy, 2008. The policy provides fl exibility in the areas of microsavings, microcredit, microinsurance and money transfers. The policy seeks to:

• Develop simpler microfi nance services to cover the geographical and socioeconomic diversities of Nepal;

45 Pradhan, Krishna Kumar. “Development Finance”, Nepal Rastra Bank in Fifty Years, Nepal Rastra Bank, Kathmandu, Nepal, July 2005.

46 Directive No.17/067 Unifi ed directives 2067, Bai.Bi.Ni,Bi/niti/paripatra/50/066/67/ dated 2067.3.32/16 July 2010-09-14.47 Directive No.20/067 Unifi ed directives 2067); Bai.Bi.Ni,Bi/niti/paripatra/50/066/67/ dated 2067.3.32/16 July 2010-09-14.


25


• Provide a legal basis to both the suppliers and the receivers of services to work together on the basis of mutual understanding and co-operation;

• Provide support to develop and strengthen institutions and build capacities of MFI practitioners through training;

• Establish a National Microfi nance Development Fund to mobilise funds from domestic and donor agencies, and provide wholesale fi nancing to microfi nance institutions;

• Legally recognise local community institutions and savings credit groups involved in microfi nance and linked to other microfi nance institutions;

• Encourage microsavings and adopt a simplifi ed policy for MFI deposit mobilisation;

• Establish a second tier institution (STI) under the NRB for effective regulation, supervision, monitoring and evaluation of microfi nance institutions.

However, most stakeholders, including FINGO representatives and MDBs, are not in favour of the last initiative. Mr. Dharma Raj Pandey, Chairman of Nepal Microfi nance Bankers' Association says, “Our demand is to be supervised and regulated directly by NRB”. Mr. Pitambar Prasad Acharya, Chairman of MIFAN adds, “We are not sure if this will be positive for FINGOs...now we are doing well; in [the] future we don't know what to expect”.48

In order to effectively regulate fi nancial intermediaries, such as MDBs, SACCOs and FINGOs, a greater degree of monitoring and supervision is required. This can be achieved by either strengthening the supervision structure under the NRB or by the establishment of a second tier institution. For now, the NRB is more inclined towards establishing a separate entity and a draft of the Microfi nance Bill enshrining this has been submitted to the Government of Nepal for consideration.

3.6.3 WHOLESALE FUNDS

The Rural Self Reliance Fund (RSRF) was established in 1991 to provide credit to rural and deprived people to carry out income generating activities, thereby helping them achieve economic self-reliance. The RSRF is managed by the NRB and provides wholesale lending to NGOs, co-operatives and fi nancial intermediaries. Government of Nepal and Nepal Rastra Bank have provided a corpus fund of NPR 20 million (USD 273,261) and NPR 100 million (USD 1,366,307), respectively to the RSRF. However, according to microfi nance experts, the funds available to each institution through the RSRF (NPR 2,000,000 or USD 27,326) are quite limited and take too long to obtain (approximately 6 months).49

48 Based on expert interviews conducted in June 2010.49 Expert interview with Mr. Pitambar Prasad Acharya, Chair of MIFAN and Executive Director of DEPROSC Nepal and Ms. Ambika

Pradhan, Principle Director, Manushi FINGO.

“We are not sure if this [establishment of an STI]

will be positive for

FINGOs...now we are doing

well; in [the] future we don’t

know what to expect”.

- Pitambar Prasad Acharya

Chair of MIFAN


26


3.7 DEPOSITOR PROTECTION/DEPOSIT INSURANCE

In its 2006-10 strategic plan, the NRB outlined that a “deposit insurance system will be initiated for safeguarding public depositors, particularly the small savers who cannot assess risk”. Furthermore, NRB has declared in its Monetary Policy for 2010-11 that necessary policy and institutional arrangements will be made to protect the interest of small individual depositors by means of compulsory insurance of saving and fi xed deposits of up to NPR 200,000 (USD 2,733). The issue of deposit insurance has been in discussion for a while and there are several initiatives have been taken in this direction, which are at different stages of development. Some of them are listed below:

• According to press reports,50 the Deposit Credit Guarantee Corporation (DCGC) has increased its paid-up capital to NPR 210 million (USD 2.87 million) and launched a programme, effective from July, 17 2010, whereby the entity will insure savings and fi xed deposits up to NPR 200,000 (USD 2,733), to be held initially at class D institutions. The entity would charge NPR 0.20 for every NPR 100 guaranteed. Depositors with a bankrupt institution would get their money back within 90 days from the date of liquidation. Such deposit insurance, however, is not compulsory and it remains the responsibility of the individual depositors to cross check with the institution whether their deposits are guaranteed or not. However, in interviews held in June last year with experts and representatives from the NRB, FINGO and Commercial Bankers Association, most stakeholders are not in favour of DCGC being responsible for this function, and doubt the entity's capacity (in terms of manpower, capital and technical ability).

• After the recent crash of Nepal Development Bank, NRB has paid greater attention towards deposit insurance and is thinking of launching a system under the NRB that would cover up to NPR 200,000 (USD 2,733). During an interview, NRB offi cials mentioned that the entity is planning to create a holding company to provide deposit insurance (possibly one holding company for both commercial banks and MDBs or two separate entities). NRB envisages that commercial banks would have a stake and contribute towards raising the capital for this entity. However, the NRB recognises that they would have to issue the necessary regulation (as BAFIA does not allow for deposit insurance business) and would also need to acquire the technical expertise. However, given the country's current political situation, the NRB is doubtful if the proposal will be approved in the near future.

• NEFSCUN is also considering getting into deposit insurance, but this is at an early stage. They are considering operating a deposit guarantee system for all SACCOS, but this would require a high degree of commitment from the member. NEFSCUN representatives recognise that they would face capacity constraints in managing such funds, and that if SACCOS are asked to deposit 10% of their liquidity at NEFSCUN for the purpose of deposit guarantee, many of them will be reluctant.

50 My Republica Newspaper: http://www.myrepublica.com/portal/index.php?action=news_details&news_id=20996 and The Himalayan Times: http://www.thehimalayantimes.com/fullNews.php?headline=DCGC%27s+deposit+guarantee+&am

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